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If confirmed, Jack Lew, the President’s nominee for Treasury Secretary, will oversee IRS enforcement of tax laws and will oversee the development and analysis of tax proposals, among other things. It would therefore be reassuring if Lew did not seem unaware of what is going on in tax havens, and unaware of the problems with proposals to exempt corporations’ offshore profits from U.S. taxes.

Much has been made of the fact that Lew, who worked at Citigroup before serving as chief of staff to the President, had an investment in a fund registered in the Cayman Islands, a notorious offshore tax haven.

Lew told the Senate Finance Committee on Wednesday that the fund was set up by Citigroup, that he didn’t know where it was based, and that he lost money on it in any event.

Lew “Unaware of Ugland House” in the Cayman Islands

What’s actually alarming about Lew’s comments before the committee is that he didn’t even seem to understand the crisis in our tax system that the Cayman Islands and other tax havens are taking advantage of.

For example, Republicans on the committee told of how the fund in question was registered in Ugland House, a small five-story building in the Cayman Islands where over 18,000 companies are officially headquartered. Obviously, most of these “companies” consist of little more than a post office box. Profits are shifted from real business activities in countries like the U.S. into these “companies” in Ugland House. The profits can then be designated as Cayman Island profits, because the Cayman Islands has no corporate income tax.

Those of us who follow tax issues know that Ugland House has been discussed for years at Congressional hearings — although Wednesday’s hearing may be the first time that it was brought up by Republicans.

The Washington Post describes the back-and-forth during the hearing on this topic:

Lew argued that “the tax code should be constructed to encourage investment in the United States.”

“Ugland House ought to be shut down?” Grassley asked.

“Senator, I am actually not familiar with Ugland House,” the witness pleaded. “I understand there are a lot of things that happen there.”

Lew Unaware that Offshore Tax Avoidance, Not Just Tax Evasion, Is a Problem

Equally troublesome is Lew’s defense. “I reported all income that I earned. I paid all taxes due.”

This completely misses the point and misses the point of the debate over tax reform. No one has suggested that Lew committed tax evasion — the criminal act of hiding income from the IRS. The Cayman Islands and other tax havens are certainly used for tax evasion, but that’s not the issue here.

The much larger problem is that our tax system allows massive tax avoidance — practices that reduce taxes that are mostly legal, but in many cases should not be legal — and that tax havens like the Cayman Islands are exploiting this weakness.

Lew probably did pay all the taxes that were due under the tax laws as they’re currently written. The same is true of General Electric, Boeing, Pepco, Verizon, Wells Fargo and the dozens of corporations that paid nothing over several years because the tax laws allowed it. The scandal is not that laws were broken, but that the laws actually allowed this.

Is Lew Unaware that the Administration Has Rejected a “Territorial” Tax System — Or Does He Know Something We Don’t?

One Senator at the hearing asked Lew about the possibility of the U.S. shifting to a “territorial” tax system — which is a euphemism for a tax system that exempts the offshore profits of corporations.

Lew said “there is room to work together.” He said [subscription required] “We actually have a debate between whether we go one way or the other [towards a territorial system or a worldwide system], and we have a hybrid system now. It’s a question of where we set the dial.”

This is alarming for those who thought that the administration had already wisely rejected moving to a territorial system. As CTJ has explained in a report and fact sheet, U.S. companies now can “defer” (delay indefinitely) paying U.S. taxes on their offshore profits, which creates an incentive to use accounting gimmicks to make their U.S. profits appear to be “foreign” profits generated in a tax haven like the Cayman Islands. Under a territorial system, they would never have to pay U.S. taxes on offshore profits, which would logically increase the incentive to engage in such tax dodges.

A year ago, the Obama administration stated that it opposes a “pure territorial system.” CTJ pointed out at the time that a little more clarity is needed because probably no country has a “pure” territorial system, and the “impure” ones are facilitating widely reported tax avoidance in Europe and across the world.

That clarification seemed to arrive when Vice President Joe Biden went out of his way to criticize the idea of a territorial tax system at the 2012 Democratic convention, referring to a study concluding that it could cost the U.S. hundreds of thousands of jobs.

We hope that this is simply another case of Lew being uninformed, and not an indication that the administration may shift towards favoring a territorial system.